Don’t Trust That Hammer

Posted by barkand on March 16, 2011 under Bollinger bands, Candlestick charts | Be the First to Comment

If you look at a daily chart of the S&P500 – which you can do in this post – you will see that yesterday’s action formed what appears to be a very handsome hammer. Don’t trust it.

There are two reasons why you should not grab that hammer. First we have to consider how the “price” of the index is calculated. In yesterday’s mini-panic at the open, it took a moment or two or three to find an equilibrium price for many NYSE stocks. So the opening value of the S&P500 was calculated using the last price from the previous day. (This is true also for the DJIA.) In reality, the market opened – eventually – down more than 2% but it isn’t reflected in the chart. What appears to be a hammer was actually a long white candle, which is not the worst-looking candle you could see, but it isn’t clear what it means in the current circumstances.

Even if it was a hammer, we should consider where it is. The market still closed below the lower Bollinger band. We want to see a bottom made within the bands, along with some bullish candle structures and with volume rising and falling appropriately.